IV. The Duty Of Good Faith And Fair Dealing

IV. The Duty Of Good Faith And Fair Dealing

A. The Nature Of The Duty Of Good Faith And Fair Dealing

The duty owed to the policyholder by the insurance company, commonly described as a "fiduciary" duty even by insurance companies, has been the subject of much litigation. Some central truths are apparent.

The duty of good faith and fair dealing implicitly requires insurance companies to be fair and honest with their policyholders:

The duty of good faith and fair dealing that an insurer owes an insured obligates the insurer to refrain from (1) engaging in unfounded refusals to pay policy proceeds, (2) causing unfounded delay in making payment, (3) deceiving the insured, and (4) exercising any unfair advantage to pressure an insured into settlement of the insured's claim."

At least one insurance company has echoed these points in its internal claims manual, stating the "most positive way to [meet the duty of good faith] is to look for coverage in . . . policies, and not to look for ways to deny coverage." Thus:

[I]n considering coverage questions, the policyholder should be given the benefit of any reasonable doubt. Our goal is to find coverage wherever possible, not ways to avoid our obligations. Our dealings with claimants must be conducted fairly, courteously, and honestly.

Insurance companies do not dispute that policyholders are owed an implied duty of good faith and fair dealing under any insurance policy. In fact, some of the most succinct definitions of good faith come not from the courts or from learned treatises, but from the insurance companies themselves. For example, Continental Casualty has stated:

Insurance is an agreement whereby parties give valuable consideration for protection from and indemnification against loss, damage, injury, or liability. As servants of the public, insurance companies are held to the universally high standard of `good faith.'

Continental further explained:

If the insurer is motivated by selfish purpose or by the desire to protect its own interests at the expense of its insured's interest, bad faith exists, even though the insurer's actions were not actually dishonest or fraudulent.

Similarly, Century Indemnity has stated:

Good conscience and fair dealing require that the insurer not pursue a course which is advantageous to itself while disadvantageous to its policyholder.

Aetna has also long acknowledged the insurance industry's duty of good faith and fair dealing:

Over-riding all policy provisions is the insurance relationship existing by reason of the liability contract which imposes upon the company the obligation to act in good faith and in the interests of the insured in the defense and settlement of claims.

Hartford probably said it best:

[O]ur Supreme Court has recently and emphatically held an insurer to the high standards of a fiduciary: In approaching the inquiry, great weight must be placed upon the character of an insurance policy as a contract of adhesion. It is equally important to emphasize that `[a]n insurance contract is preeminently one of the utmost good faith.'

B. The Failure to Practice What Is Preached: Common Insurance Industry Techniques Used To Pervert The Duty Of Good Faith and Fair Dealing

Unfortunately for policyholders, insurance company claims handling practices often contravene the spirit of their professed beliefs and fiduciary duties. For instance, insurance companies have brought bad faith claims against their own policyholders. These actions are commonly known as reverse bad faith claims. Every court to have considered the issue has rejected it. To do otherwise would exploit the already weak bargaining position of policyholders seeking insurance coverage:

As the holder of the purse strings, the insurer has a certain built-in protection from such evils. On the other hand, the insured, who often finds himself in dire financial straits after the loss, must have the equal footing which is provided by the ability to sue the insurer for bad faith. There are other avenues for the insurer to pursue in the event that an insured submits a fraudulent claim. An insurer drafts the policy, can refuse the insurers claim, and could assert a cause of action against the insured for fraud.

While the duty of good faith and fair dealing has been held to apply to both insurance companies and policyholders, only insurance companies can be said to owe a fiduciary duty. In fact, insurance companies have argued that very proposition. In one instance, the insurance company argued that "any fiduciary duty rests with the insurers on behalf of the insured, not vice versa." However, insurance companies only take this position when suing other insurance companies or when the insurance company is forced to step into the shoes of a policyholder. This contradiction reveals another great irony of bad faith litigation; bad faith litigation most frequently occurs between insurance companies, not policyholder versus insurance company.

C. Judicial and Statutory Recognition Of The Duty Of Good Faith

1. Judicial Recognition

Most states recognize that insurance companies owe their policyholders a duty of good faith and fair dealing. These states recognize that policyholders possess a common law private right of action for breach of that duty. The standard for determining whether punitive damages apply to a breach of good faith, of course, varies from state to state.

2. Statutory Recognition

In addition, at least 48 states have passed Unfair Claims Settlement Practices statutes which prohibit insurance companies from breaching their duty of good faith and fair dealing. Some states also allow a bad faith claim against an insurance company under its Consumer Protection Act.

Many of these statutes do not provide a policyholder with a private right of action. In jurisdictions which do not permit policyholders a private right of action, complaints under the statute can only be made by the state insurance commissioner. In these jurisdictions, unfair claim settlement practices statutes are rendered a nearly worthless safeguard. Insurance commissioners have "rarely exercised" their authority under these statutes to protect policyholders from insurance company misconduct. Perhaps this is because most insurance commissioners come from the insurance industry and leave their government office in order to accept an offer of high-level employment with an insurance company (at a much higher salary).

Nonetheless, the punishment provided under these statutes can be severe. For example, under Pennsylvania's Unfair Insurance Practices Act, an insurance company which violates its duty of good faith and fair dealing can have their license to operate suspended or revoked. The same is true under West Virginia and Ohio statutes. Despite the statutory authority permitting administrative sanctions, insurance companies are rarely, if ever, punished for wrongful claims practices.

States which have adopted statutory penalties as harsh as a revocation of authority to operate do not take insurance company bad faith lightly. BMW makes clear that an award of punitive damages must be compared to the maximum civil or criminal penalties that could be imposed in comparable cases. The revocation of an insurance company's license to sell insurance within the state is a much more severe punishment than almost any award of punitive damages. Indeed, lesser punishments negate the very purpose of punitive damages -- to deter future misconduct. Whether or not policyholders have a private right of action under statutes prohibiting insurance company misconduct, these statutes provide very important measures to determine the permissible limits of bad faith awards under BMW. Juries should be made aware of this important consideration when fixing an award of punitive damages.

The high courts of Pennsylvania, Ohio and West Virginia have each recognized that insurance companies owe their policyholders a duty of "good faith." Each state has also adopted some type of statutory safeguard to protect against insurance company bad faith.

3. Pennsylvania

The Pennsylvania Superior Court in Romano v. Nationwide Mutual Fire Insurance Company, noted that it was "because of the special relationship" between an insurance company and its policyholder, that "[t]he Pennsylvania Supreme Court has long held that an insurer must act with the 'utmost good faith' toward its insured." Similarly, the Pennsylvania Supreme Court in Dercoli v. Pennsylvania National Mutual Insurance Company, after acknowledging that "utmost fair dealing should characterize the transactions between an insurance company and the insured," further stated:

The [insurance companies] were bound to deal with the policyholder on a fair and frank basis, and at all times, to act in good faith. The duty of an insurance company to deal with the insured fairly and in good faith includes the duty of full and complete disclosure as to all of the benefits and every coverage that is provided by the applicable policy . . . including any time limitations for making a claim. This is especially true where the insurer undertakes to advise and counsel the insured in the insured's claim for benefits.

Pennsylvania does not recognize a common law right of action for insurance company bad faith. Thus, insurance companies' duty of good faith and fair dealing is enforced primarily by statute in Pennsylvania. These statutes are the Unfair Insurance Practices Act, the Unfair Trade Practice and Consumer Protection Law, and 42 Pa.C.S.A. § 8371 ("8371"). A copy of these statutes has been attached as Appendix C.

In 1981, the Pennsylvania Supreme Court specifically declined to create a common law remedy for insurance company bad faith in D'Ambrosio v. Pennsylvania National Mutual Casualty Insurance Company. The Pennsylvania Supreme Court held that Pennsylvania's Unfair Insurance Practices Act ("UIPA") adequately deterred insurance company bad faith. The court also held that only state insurance commissioner was empowered to bring claims under the UIPA. Courts remain steadfast in holding that there is no private right of action under the UIPA. Several decisions, however, have held that the UIPA does not preclude existing common law remedies.

In 1990, the Pennsylvania legislature responded to D'Ambrosio by enacting § 8371, creating a statutory remedy for insurance company bad faith. § 8371 sets forth the following:

In an action arising under an insurance policy, if the court finds that the insurer has acted in bad faith towards the insured, the court may take all of the following actions:

(1) Award interest on the amount of the claim....

(2) Award punitive damages against the insurer.

(3) Assess court costs and attorneys fees against the insurer.

Romano v. Nationwide Mutual Fire Insurance Company was the first decision to construe the meaning of § 8371. The court, finding that § 8371 did not define the meaning of bad faith, but that "in the insurance context, the term bad faith has acquired a universally acknowledged meaning," provided the following definition:

Insurance: "Bad Faith" on part of insurer is any frivolous or unfounded refusal to pay proceeds of a policy; it is not necessary that such refusal be fraudulent. For purposes of an action against an insurer for failure to pay a claim, such conduct imports a dishonest purpose and means a breach of a known duty (i.e., good faith and fair dealing), through some motive of self-interest or ill will; mere negligence or bad judgment is not bad faith.

The definition of bad faith supplied by the Romano court has been used by other Pennsylvania state and federal courts.

The Romano court noted that although the UIPA can only be enforced by the state insurance commissioner, a policyholder "may point to bad faith conduct as defined in various provisions of the UIPA as a basis for recovery under 42 Pa.C.S.A. § 8371." Thus:

Although the trial court lacks the requisite jurisdiction to impose sanctions under the various provisions of the UIPA and insurance regulations, we find that the rules of statutory construction permit a trial court to consider, either sua sponte or at the request of a party, the alleged conduct constituting violations of the UIPA or the regulations in determining whether an insurer. . . acted in "bad faith."

. . .

The fact that [the policyholder] makes reference to a provision of the UIPA does not divest the trial court of its jurisdiction.

Several decisions have held that a bad faith claim brought under § 8371 is to be considered independent of any claim for breach of the insurance company's obligations under the insurance policy:

[A] claim brought under section 8371 is a cause of action which is separate and distinct from the underlying contract claim . . . [A]s the language of section 8371 does not indicate that success on the contract claim is a prerequisite to success on the bad faith claim, we find that an insured's claim for bad faith brought pursuant to section 8371 is independent of the resolution of the underlying contract claim.

The court held that a policyholder's bad faith claim brought under § 8371 is independent of a claim brought for breach of the insurance policy, and that the statute of limitations period in the insurance policy had no affect on the bad faith claim. However, the court reversed the trial court's summary judgment for the insurance company on the policyholder's bad faith claim without deciding the proper statute of limitations period under § 8371. One court has recently held that the statute of limitations period to bring a claim under § 8371 is six years.

Although the Pennsylvania Supreme Court does not appear to have addressed the issue, there is substantial authority for the proposition that policyholders may maintain a private cause of action under Pennsylvania's Unfair Trade Practice and Consumer Protection Law even when the policyholder's allegations fall within the practices prohibited by the UPIA.

4. Ohio

The Supreme Court of Ohio in Zoppo et al. v. Homestead Ins. Co. set forth the standard for evaluating whether an insurance company has fulfilled its duty of good faith and fair dealing:

An insurer fails to exercise good faith in the processing of a claim of its insured where its refusal to pay the claim in not predicated upon circumstances that furnish reasonable justification therefor.

Under Ohio law:

"[A] breach of this duty will give rise to a cause of action in tort against the insurer. The tort of bad is not a tortious breach of contract, for no matter how willful or malicious the breach, it is no tort to breach a contract . . . [T]he legal duty of good faith imposed by law on the insurer applies with equal force to the company's settlement of third party claims against its insured as it does to those claims brought by the insured himself.

An insurance company's breach of its duty of good faith and fair dealing sounds in tort "irrespective of any liability that might arise from a breach of the underlying insurance contract. Thus, limitations clauses contained in the insurance policy are inapplicable to claims alleging a breach of the insurance company's duty of good faith and fair dealing.

In Zoppo, the Ohio Supreme Court clarified that "intent is not and has never been an element of the reasonable justification standard." The court found that the insurance company breached its duty of good faith and fair dealing to its policyholder where the policyholder's bar was destroyed by fire and the insurance company's investigation: (1) focused primarily on the policyholder; (2) failed to seriously explore evidence that other parties had threatened to burn the building down; (3) failed to locate key suspects or verify alibis; (4) did little more than ask cursory questions of other suspects; (5) failed to follow up with witnesses, despite evidence that one bar patron had bragged to others about setting the fire; (6) did nothing to verify the policyholder's story that he was out of state when the fire started. There was also evidence that one witness was paid to change his statement and implicate the policyholder in starting the fire.

The Zoppo court reversed a lower court finding that under these facts, the policyholder had failed to show bad faith by its insurance company. The court then reviewed whether the insurance company's bad faith warranted punitive damages:

Punitive damages may be recovered against an insurer that breaches its duty of good faith in refusing to pay a claim of its insured upon proof of actual malice, fraud or insult on the part of the insurer.

The court found that although there was no showing of fraud, and although the insurance company did not act with actual malice, "the trial court had the obligation to determine that there was sufficient evidence that the [insurance company] consciously disregarded the [the policyholder's] rights." The court found that the insurance company's one sided investigation justified the award of punitive damages. Furthermore, "an insurer who acts in bad faith is liable for those compensatory damages flowing from the bad faith conduct of the insurer and caused by the insurer's breach of contract.

Ohio specifically exempts insurance companies from its Consumer Sales Practices Act. In addition, Ohio courts have steadfastly held that there is no private right of action under the Unfair and Deceptive Trade Practices Act, Ohio's statute proscribing unfair trade practices in the insurance industry.

5. West Virginia

"West Virginia first party insurance damage law was essentially born in 1986 with the decision in Hayseeds, Inc. v. State Farm Fire & Cas." In Hayseeds, the court held that

We consider it of little importance whether an insurer contests an insured's claim in good faith or bad faith. In either case, the insured is out his consequential damages and attorneys fees.

The court held that whenever the policyholder substantially prevails in a property damage suit against the insurance company, the policyholder is entitled to reasonable attorneys fees and damages for delay in the settlement, aggravation and inconvenience.

Whether a policyholder has substantially prevailed is determined by:

the status of the negotiations between the insured and the insurer prior to the institution of the lawsuit. Where the insurance company has offered an amount materially below the damage estimates submitted by the insured, and the jury awards the insured an amount approximating the insured's damage estimates, the insured has substantially prevailed.

However, determining whether the insurance company acted in good faith towards its policyholder remains important in establishing an insurance company's bad faith failure to settle. In Shamblin v. Nationwide Mutual Insurance Companies, the court held:

[W]henever there is a failure on the part of the insurer to settle within the policy limits where there exists the opportunity to so settle and where such settlement within policy limits would release the insured from any and all liability, that the insurer has prima facie failed to act in its insured's best interest and that such failure . . . constitutes bad faith towards the insured.

The court held that it then becomes the insurance company's burden to establish that it attempted to reach a settlement and that any failure to do was based on reasonable grounds. "The proper test is whether the reasonably prudent insurance company would have refused to settle within the policy limits, "keeping in mind always its duty of good faith and fair dealing with its insured." Among the factors that the trial court should consider in determining a bad faith failure to settle is whether:

(1) the insurance company conducted an objective investigation;

(2) the insurance company had a reasonable basis to conclude that there was a genuine and substantial issue as to the liability of the insured;

(3) there was a potential for a substantial verdict in excess of the policy limits against the insured.

Policyholders in West Virginia also are entitled to a private right of action under West Virginia's Unfair Trade Practices Act ("UTPA"). The first case to recognize a private right of action under the UTPA was Jenkins v. J.C. Penney Cas. Ins. Co., decided in 1981. Since then, Jenkins and its progeny have clearly set forth the requirements to file a claim under the UTPA. A claim brought under the UTPA relies on a violation of the statute which indicates a "general business practice" by the insurance company. To establish a general business practice, the policyholder must show that there was more than a single isolated violation of the UTPA. Doing so requires:

1. Proof of several breaches by an insurance company of 33-11-4(9), or;

2. Proof of multiple violations of 33-11-4(9) occurring in the same claim, or;

3. Proof of other violations by the same insurance company to establish the frequency issue. Proof can be obtained from other claimants and attorneys who have dealt with such company and its claims agents, or from any person who is familiar with the company's general practice in regard to claim settlement

In addition, the policyholder asserting a private right of action under the UTPA need not show that it has "substantially prevailed as required under the Hayseeds common law approach. At least one court has found a private right of action under 33-11-4(1)(a) of the UTPA prohibiting misrepresentation and false advertising of insurance policies.

Punitive damages are allowed under causes of action brought under a Hayseeds approach or the UTPA.

BAD FAITH IN INSURANCE COVERAGE DISPUTES AND THE PUBLIC NATURE OF INSURANCE -- UNDERSTANDING THE RECOVERY TOOLS AVAILABLE TO POLICYHOLDERS

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last modified Dec 29, 2003 / 12:53 AM, GMT